Building My Portfolio for Retirement, with Dividends and Bonds

In my mid to late 40’s, my focus of late has been more on planning for retirement and how I will generate a consistent monthly income to fund my retirement. I find myself in between the need to increase my portfolio through capital appreciation, but also for the need to generate monthly income in retirement. I can take early retirement nine years from now, and I fully plan on doing so! What I will need at that time is monthly income.

I’ve weighed the pros and cons. I’ve come to the conclusion that I’m better off creating a stable portfolio of monthly income, through dividend stocks and bond ETFs. I feel this is more beneficial for me, than trying to hedge my bets on where the markets might or might not be nine years from now through indexing. Right or wrong, it’s a personal decision I’ve arrived to through my own investing experience. The bottom line is I prefer to hold shares in companies directly, rather than a basket of stocks in an index. Although Index ETFs such as XIU or XIC do pay distributions, the yields at 2.5% and 2.3% respectively, is much lower than holding dividend stocks directly.

While I’m keeping my bond ETFs and bond funds, I had reached the point where it was an opportune time to sell my equity index funds at profit, and purchase dividend stocks that were fairly priced. So on Friday I sold my index equity funds, and set buy prices on dividend stocks I’ve had on my watch list over the last year or so. This is something I’ve been contemplating for several months now, and I started to pull the trigger this week in my TFSA. I had to be 100% certain it was the right decision, and I had no regrets in doing so. I’ve decided to write a couple of posts this week, on why I’m switching my index equity holdings to dividend stocks. I reiterate this is my own personal decision, and everyone has an investing strategy that suits them – it may be 100% indexing for you. 😉

Early Retirement via My Pension Plan

Working in healthcare full-time and part-time over the years has been generous, and I’m always thankful for that. Even when I ran a web company for several years, I still kept my hours in healthcare part-time or casual in order to keep my benefits and membership in the pension plan. I signed up for our pension plan at work when I was a casual employee starting out, because I realized the benefit in doing so. While my co-workers didn’t invest at all, or piled their savings into mutual funds on their own, I realized that my employer would match my contributions and I would have a defined pension (or cheque every month) when I retired. I realized this was worth gold!

I’m one of the fortunate ones who have a defined benefit pension plan. That means I’m guaranteed a monthly income at a fixed amount regardless of the market. I’m guaranteed that pension as long as I am alive, and as long as the plan is fiscally sound. I can retire anytime once I’m 55. Obviously I can work longer and collect more from my pension, more with each year worked, but I’ve already decided I will take whatever benefit I am entitled to at 55 and collect! 🙂 For me it’s a lifestyle choice. That’s only nine years away, and since I’m already living a semi-retired lifestyle anyway, it’s not going to be a big leap or life style change. In fact, I’m looking forward to it!

I’m more than thankful for that pension, but obviously it’s not going to be enough. Government benefits are also going to be a nominal addition to that amount once I’m 65. That’s where my investment portfolio comes into play, to bridge my pension and government benefits, and provide the additional income I need to live a comfortable lifestyle. My investments are both my security cushion and an additional source of income I will require in retirement.

Drawing Down an Indexed Portfolio in Retirement

Classic retirement planning states that you can draw down 4% of your portfolio adjusted annually for inflation. This based on the work of William Bengen, assuming a 50% equity and 50% bond portfolio. If you have portfolio of index funds and index ETFs, most of your income comes from drawing down your portfolio capital. Even with a big chunk of Bond ETFs which provide monthly distributions, or holding ETFs such as XIC and XIU mentioned above, there is no way around drawing down your original capital. The idea is that while you draw down 4% of your nest-egg, you will also be accumulating at least the 4% back (or far more) in capital appreciation, dividend distributions, reinvested dividends into new fund units, and reinvested interest income of course from bonds. Rick Ferri in the U.S. has written extensively on drawing down an indexed portfolio in retirement. The bottom line however, is with an indexed portfolio you are at some point drawing off the capital of your portfolio.

What If We Have Another Financial Crisis?

But what if your indexed portfolio doesn’t increase when you retire? What happens if you retire at 65 and we have another 2008 and 2009 crash? Can you draw down 4% your portfolio when it has lost significant value and continues to depreciate? I don’t know the answer to a question like that. But what I do know is I simply won’t have the time to recover from another market crash when I’m 65 or even at 55. While stock markets always bounce back, losing a third or half your portfolio value when you are relying on its capital (value) for retirement is going to be unsettling. On the other hand if you have a good allocation of bonds, then you do have some necessary income and a cushion when markets tank – unfortunately many people did not back then, and they still don’t today.

If we have another financial crisis, I would rather be holding all my equities in dividend paying stocks, and here are three reasons why. (1) Dividend stocks pay you quarterly and even monthly distributions for being a shareholder, regardless of their share price. (2) Many companies cut or suspended their dividend temporally during the crisis. However, most continued to pay dividends, and the U.S. and TSX Aristocrats even increased them in 2008 and 2009. (3) Although many investors’ endured great stress by watching their portfolio decline in value, they still collected monthly dividend income from their dividend stocks. It may not be much of a comfort, but those who were able to endure and hold on to their dividend paying stocks, made tremendous gains in the few years that have followed. In other words dividend stocks still paid you income.

Dividend Investing vs. Index Investing

That’s where dividend stocks come into play, and in my opinion can provide a benefit over index equity ETFs or index funds. Here is the key point: If you have a basket of dividend stocks for the equity component of your portfolio, then regardless of the share price of your securities (capital), you will still have the same number of shares, and the same dividends paid out (income). Actually dividend yield increases when share prices decline. So if you can hold steadfast when your dividend stocks plummet you will actually receive slightly more the same dividend income. 😉

In my opinion, this is where dividend investors have the upper hand. Regardless of their overall portfolio value (share price) their monthly income (dividends) remains constant. So while many long time dividend investors, such as Susan P. Brunner among others, have noted their portfolio value may oscillate wildly during times of market crisis, their monthly dividend income remains relatively constant.

There is a trade off of course. What you give up for the steady income is the potential for larger gains. For example, you won’t beat the market holding bellwether stocks like Johnson & Johnson (JNJ) or Procter & Gamble (PG). JNJ is a pretty stable stock, and its’ very unlikely to outperform the market in any given year. But it will give you a consistent 3.5% yield with lower volatility than the overall market. And you will likely see an increase in JNJ share price over the years. But when your equity investments decline in value they will still generate income through dividends.

I’m Keeping My Bonds, Thank You!

While I’m willing to abandon my equity index funds for dividend stocks, I’m certainly not willing to go with a 100% equity portfolio route, or hold a 100% dividend stock portfolio! Part of setting up my portfolio for retirement is to sleep well at night. I was reminded of that back in August 2011 as well as the financial crisis, how important bonds are in a portfolio to cushion the blow. But bonds did much more than just cushion the blow, they provided monthly income!

Conclusion

Putting it all together, this is a strategy that makes sense for me in my current situation. It may not be for everyone, but a portfolio of 50% bonds/fixed income and 50% dividend stocks suits me just fine. I’m looking forward to taking early retirement, and having a portfolio that pays me regular income. When markets oscillate wildly or decline, I know my dividend stocks and Bond ETFs will continue to pay me consistent monthly income. In my next post, I’ll cover more about creating an income focussed portfolio.

Readers what’s your take? Do you think shifting to an income portfolio (of bonds and dividend stocks) at my age is too early? Do you prefer Index Equity Funds and Index ETFs, or do you prefer dividend stocks?

73 Responses to “Building My Portfolio for Retirement, with Dividends and Bonds”

I think it’s a great move. At this time most of my investments are in index funds and other ETF. I’ll move them toward dividend stocks little by little as I get older. You can always reinvest those dividend income if you don’t need them right?
The pension is a great move too. Pension + dividend income + other side jobs + government pay = a pretty nice retirement.

Joe thanx for posting! Sure you can start moving part of your portfolio to dividend stocks. Small baby steps is the way to go. Maybe 10% for now then 20% etc. until you get a feel for it.

While I’m still building the portfolio I continue to DRIP all my dividends (when possible) and compound the number of shares I have in each company. Once I’m fully retired then I’ll stop the DRIPs and collect the dividend income. The nice part as you mention, is I can switch the DRIPs on or off for different stocks, or the entire portfolio, depending when I need the income. The same applies to the distributions from Bond ETFs and Bond Index Funds as well.

I like your equation. 😉 Class dismissed!

Cheers

al

Aug 19. 2012

Great stuff- i am 55-45 bond to stock. have most funds at Vanguard. bond funds are very diversified and include a good amount in corporate bonds. these have been amazing in terms of results the past few years. i am watching interest rates and wonder if the long term and intermediate corporates are worth holding when interest rates rise. will the loss of the NAV outweigh the increase in interest rate of holdings. Your thoughts. al

Wow, what a complete and detailed look at the benefits of dividend investments vs equity funds. If you were going to wait until after 60 to retire I would say you’ve pulled the trigger too soon on moving out of equities, but considering your time horizon your move makes sense. It also makes it much easier to budget where you will be income wise in 9 years.

That being said, don’t forget about the emerging markets which could help boost your returns substantially and could also provided diversification.

Hey Money Infant ! I’m not moving out of equities, I’m just switching my equity index funds for dividend stocks 🙂 Though I am increasing the bond/fixed-income allocation from 46% to 50% sooner than later.

And yes you are absolutely right, with an income portfolio you know exactly what your monthly income will be – that’s my post later this week or next! 🙂

Cheers

Michel

Mar 13. 2012

I like the move to dividends. The bond allocation will let you sleep at night during difficult markets. Myself I’m 90% stocks, with a regular teachers’ pension, at 59 years old. Good move for you. I really do not like bonds when interest rates are just about ready to go up.
Michel

I hear you on bonds. Here’s my thoughts looking back to the late 80’s when I had GICs paying 12%. If rates rise, then I’ll keep topping up my bonds, while they go on sale, but I will also split my fixed-income. For example if GICs start paying 5%, I would have no hesitation to split my fixed income to half bonds and half GICs and MMKT Funds. As an experienced investor, what do you think?

Cheers

Michel

Mar 13. 2012

I like your thinking on bonds. But what I watch for is inflation. Cost of living goes up, rates rise, inflation rises and GICs just keep up. When GICs paid 12% in 1980 (the year my first son was born :))inflation was also 12%, so people don’t realize that they were just keeping up with the higher cost of living. Your dividend stocks (growing dividends and all…) should keep you above the CPI.
Note: Imight be an experienced investor but not a qualified advisor.

I have a couple dividend holdings right now, but I have started to think it might be a little early to build my portfolio all around dividends. I am not going to sell the holdings I have now (selling is not part of the plan) but my net purchase is going to be either XIU or VUS so I can get some of the growth I might miss with the portfolo I currently have.

I still love having dividend stocks so I will add them when they are priced right but I am going to add some indexing to my portfolio for the next while.

Poor Student No need to sell your holdings, and sounds like indexing is what agrees with you best. I think your approach of working with both index products and dividend stocks to see what works for you is fine. 😉

There is a misconception here in the comments that dividend stocks are ONLY about income. But dividend stocks are also about growth! When your DRIP (or reinvest your dividends into new shares) you are actually increasing your portfolio with adding more shares. It’s the same thing as reinvesting your index/fund untit distributions into new units.

Right now I’m reinvesting my dividends (when possible) into new shares to grow my portfolio. When I retire, I simply flip the switch to receving my dividends in cash. Voila!

I currently own Claymore CLF, and TD e-series Canadian Bond Index, and to be honest that’s it – just these two. I like CLF (and CBO for that matter) becuase these are 1-5 year laddered bonds, the duration being short-term. This makes them less susceptible to interst rate increases, than their longer term counterparts.

For me I already have a large postion in bonds, so ramping up the percentage to 50% or even 45% is no big deal. It’s not such a shift.

In your case you would be going from 0 to 50 in a sudden change, and you would be paying premium to buy your bonds in this market – i.e. at their highest price. I’m not a professional financial advisor, so I can’t really advise you. I think you would want to have some bonds to cushion the market volatility and give you some income, but I’m not sure you need to do it all in one swoop, especially with the threat of rising interest rates in this bond market. Even though I’m striving for 50% bonds, I think I would give some considerable thought here… 😉

Cheers

Kuku

Mar 13. 2012

Very interesting and detailed post.

Since you are still in forties (young), are part of a good Defined Benefit plan and assuming that you will be getting at 50-60 percent of your best five years of earnings at retirement time which will be indexed to inflation, with possibly no mortgage and children grown up and self- sufficient (lot of assumptions but all very likely valid, I believe that you can be more aggressive in your approach. 50 percent fixed component is too high and overly defensive. Furthermore, if one has an RSP, the investments can continue to age 71 or beyond.

Dividend stocks can provide not only stable income but also opportunities for growth. There would be periods of downturn but with regular contributions and dollar cost averaging, it would all come out in the wash. With DRIPS, one would get higher number of shares for the same dividend in a downturn.

I also believe that one should not forget to invest in enjoying the present. There should be reasonable but not excessive focus on retirement. Retirement may not be absolute, especially if the health remains good. There may be opportunities for pursuing other gainful and enjoyable active careers in retirement or doing volunteer work.

KuKu I really appreciate your thoughtful and detailed comment. 😉 I think your bang on with most of your assumptions, for most people.

However I’m willing to take less risk with less growth, but generate more income. Everyone thought they could be more agressive and take more risk in the years leading up to 2008 – we all know whats happened since then. 😉 Even if I kept my 40% bonds, would it make that much difference to ramp it up to 50%?

PS
Don’t worry I already have retirement planned out, and know exactly what to do! 🙂 It’s much the same as I’m doing now with a bit more travel added in. LOL I should exercise more as well!

Although I have yet to start investing. I have made my decision to invest mostly in ETFs as I like the diversification without the need for a lot of capital. After I set up a good base, only then will I decide if I wish to start slowly breaking them down to invest into individual dividend stocks.

I love articles like these. Through these I am starting to develop my own strategy.

CandianFinances That’s the key isn’t it? Knowing exactly what investment style suits you, and sticking with the plan! For me I feel the same way about holding dividend stocks, I don’t worry about the market, becuase the majority of companies in my portfolio are solid enough I don’t have to… 🙂

1) You’ve got a DB pension which is what I consider a BIG bond. Guaranteed monthly income is the perfect kind of income.

2) With bond funds and bond ETFs, you’ve got even more fixed income security, to layer on top of your pension.

3) With dividend paying stocks, especially a diversified basket of at least 15-20, you’re in good shape to survive most market downturns with dependable income and ride market recoveries with, again, dependable income.

After 55, you can work on your side jobs, or not, and just enjoy everything life has to offer. If you have your health and some stable income that covers all daily living expenses from the pension, then the bond ETFs and the income from dividend-payers is gravy.

What an amazing position to be in.

Government benefits will kick in at 65, and you can take CCP at 60. That’s a very diversified plan, with multiple income streams.

In closing, dividend stocks provide not only stable income but also opportunities for capital growth. Combine this with bond ETFs and funds that simply pay to own them and keep pace with inflation, and you’ve got a killer one-two punch.

Again, I think this is a great long-term move as long as you hold multiple, established, blue-chip dividend-payers and with DRIPs, you’ll be assured to have lots of them in another few years 😉

MOA Stellar comment! What can I say? You and I see eye to eye on so many issues when it comes to investing, though I have a way to catch up to you. Once I’m 55 and retired, that is going to be the sweet spot! 🙂

Mantra I think you are absolutely right! in fact I am already smiling. 🙂

The only downside is the particular stocks I was interested in have already climbed in price past my buy points – time to work down the list now.

Cheers!

Hamilton Freelancer

Mar 13. 2012

Overall a good post, but there’s one point that stuck out for me. I’m hoping that the winking emoticon at the end of it means you realize this statement is completely incorrect:

“So if you can hold steadfast when your dividend stocks plummet you will actually receive slightly more dividend income.”

No, sir. The yield percentage may increase if a share falls in price — a 50-cent dividend is a 2.5% yield at $20 a share, and a 5% yield at $10 a share — but the actual amount of income will stay the same. 50 cents per share is still 50 cents per share.

Hamilton, your absolutely right. Thanx for catching the mistake, and I updated the post. 😉

Cheers!

Peter

Mar 13. 2012

Wow, having been a long time reader, I didn’t expect this switch so soon. I thought you were going to keep those e-series for a while.

Anyways, the only downsides to the dividend thing is that there will be specific risks with the individual stocks you hold (eg. what if you picked another RIM, YLO, or SNC lavalin? although RIM doesn’t have a dividend). With indexes, you don’t have to worry about that.

But as you said, everyone has to do whatever works for them.

Healthcare work must be quite rewarding though? Maybe you will like it so much that you will continue working beyond 55. Ha!

Yes but when you own an index fund or ETF, you own the very stocks you mentioned (RIM and YLO) by default. In fact you own several other stocks you would not even touch with a ten-foot pole, other stocks you would, and everything in between. I’ve never understood this logic with indexing. 😉 I’m not sure what percentage YLO and RIM are in the index, but it may be more thank you think.

Yes working in healthcare can be rewarding at times, I do like the aspect of helping people – I really do. However I think I will find laying on a beach in the Phillipines or working on my multi-million dollar web empire far more rewarding. 🙂

Cheers!

Maritimer

Mar 13. 2012

If you buy dividend growth stocks then your Yield on Cost will go way up over the years.

YOC= dividend rate/(average purchase price)

So if you buy a stock at 30.00 and never buy again but dividends keep increase year after year then the yield gets larger. The larger the Yield on Cost, the harder your money works for you so you don’t have to work for money.

The current yield and yield on cost issue I grasp. Also the important issue is that the income received from dividends are the same.

I don’t really want to wade into a debate on YOC in these comments. Just as long as investors realize YOC is over several years, so when investors talk about a YOC of 24% they foregt to mention that was over 5 or 6 years.

It’s your current dividend yield that is important in retirement i.e. 3.5% on a particular stock. YOC is just one way to measure compounding return. But your true ROI (return on investment) is all capital appreciation plus dividend income, over the years you have been investing.

Cheers

PS Please post YOC arguments on the post linked above, and not here in these comments please. thanx 🙂

Be'en

Mar 13. 2012

Why not buy ETFs holding dividend paying stocks only like CDZ and XDV? Is there a down side to holding these for dividend income apart from the yearly MERs?

If you want to invest in ETFs that’s fine, I just prefer to actually hold shares directly in companies. When I have 100 or 200 shares in Home Depot, or 50 shares in McDonalds I can understand what I’m holding – I’m an owner in a business.

CDZ has a yield of 3.3% which isn’t bad, and XDV is 3.7% yield. Nothing wrong with those yields, and these ETFs have some great companies in them. 😉

Cheers

Vangrl

Mar 14. 2012

here’s hoping your buy order for that insurance company starting with an “m” got filled last Friday:)

Ninja, I like your strategy! You got a good plan all around based on where you are and where you want to be.

I have always preferred dividend stocks for being more predictable with the yields and its future growth in some cases (even though you have to use history to forecast and it’s not a sure thing). I find that with more predictability, you can better make your path and understand where you land.

I applaud you for continuously evaluating and adjusting. This is what reviewing a portfolio is about.

PIE Cheers! Now to get those shares for BMO, FTS, and Telus Dripping. 🙂

Ray

Mar 14. 2012

Ninja,

Hi, I’m a 17 year old student writing in from Singapore. I’m taking a personal fiance class right now, and I can relate to the concept of investing in 40% bonds, which would ensure finacial safety in the long run. However, would you recommend someone beginning to invest to allocate most of his money into individual stocks; thereby, taking the risk for either large returns, or invest in both index funds and bonds for the long run?

Hey, I am a 20 year old student in Ontario and have been studying finances and investing for a long time. If you are 17 definitely do not have 40% of your portfolio in bonds. You have such a long time frame and the stock market has always gone up over time. It may not for 1 year, 5 years or even 10 years but with the kind of length of time you are talking it is much better to hold stocks and index funds.

This is simply my opinion but because you have a long time for the markets to go up and because 40% of your portfolio will not be a lot of money realistically it would be unwise to invest in bonds. You shouldn’t be taking the money out for a while so the volatility of the stock market should not concern you other than to buy when prices are low.

Ray Thanx for the comment! Seeing a young person startign out investing is so nice to see, because you have so much time on your hands. 🙂

Poor Student is correct, at your age a 40% bond portoflio is way tooooooo conservative! You should be more around 15% to 20% (your age in bonds). Build up a solid core of index funds and safe big blue-chip U.S. dividend stocks, reinvest the dividends, and you will easily be a millionaire when you are my age. 🙂

Good job!

Dan

Mar 14. 2012

A nimble ninja is a good ninja!

I like the move, as you stated a few times in the article, when stock market volatility is kicking our collective butts and keeping us up at night you’ll sleep tight knowing your dividends are still paying for your retirement.

They act as a hedge against the most dangerous force in the market; emotions!

I’m definitely not ready to move out of my ETFs yet, but I think your move is great! Especially with the security of a DB pension. Does having a DB pension affect your bond allocation at all? Also, how many different companies are you targeting for your portfolio long-term?

I know convential wisdom says to reduce your bond percentage if you have a defined pension plan. But I look at each portfolio individually, and thus want to create stability within both my TFSA and RRSP.

I currently have over 10 companies and would like to increase this to 20 to 25 over the next 10 years. I think this is doable. 😉 30 to 40 would be ideal – but that won’t be acheivable in my case, as I want each company to have enough value to currently DRIP.

SPF Always delighted to have you drop by, and thanx for sharing your take! 🙂

Yes we are the fortunate ones to have the DBP through our employers here in Canada. I still like to have bonds (or other fixed-income) in my portfolio to help cushion the ride, and dampen the blow when markets turn – plus helps me to purchase stocks on sale. I’ll be getting the second part of this article out soon…

This is a great and creative plan. Thanks for this very detailed account of how you plan to accomplish early retirement. I have been reading your site for a while and much of what you say has prompted me to re-think index funds and mutual funds, and show more interest in dividend stocks. As a matter of fact, I made my first purchase of dividend stocks this week. I’m looking forward to building this up over the years and turning it into a source of low-tax cash flow. Good luck with your plan!

MyMoneyDesign Thanx for the comment! I’m glad you found the post inspirational. Just be sure that any significant changes you make for the long term, also fit your investment plans, you have to be 100% sure.

I would definitely get rid of the actively managed mutual funds – your likely just paying extra fees for lacklustre performance. With the index funds, you may still want to keep some and slowly shift to dividend stocks (no need to do anythng in a hurry). I thought about my plan months before I pulled the trigger.

Dividend Stocks will also lose value in market declines, the difference of course is you will receive dividend income. 🙂

In fact, my dividend has never remained constant. It has always gone up. 5 year median increase is 11.35%, with 5.29% in 2010 and 23.21% in 2007 being my lowest and highest increases.

Dividend increases tend to go down after the bear market. I have combination of low, medium and high dividend yield stock and low median and high dividend growth stock. That is stock with different patterns of yield and growth.

In 2010, some dividends were decreased, some stayed the same and some increased.

Julie You and me both! And that is exactly why I like dividends and bond distributions, I can calculate my monthly income exactly. 😉

Cheers!

al

Aug 20. 2012

Great stuff- I am 58 and semi retired. i am diversified at 55-45 bond to stock. All of my stock and bond mutual funds are with vanguard. I have quite a diversified portfolio in terms of number of funds and am about 60 % admiral shares and index based. My main question has to do with the corporate long term and intermediate investment grade bond funds. These have been amazing in terms of results the past few years. Also hold a high amount of GNMA and am concerned about the low yields that is offering, yet it seems to be holding its own over the past year. I also hold total bond index and the high yield corporate. My stock mutual fund portfolio is also quite diversified. My main question is I am watching interest rates and wonder if the long term and intermediate corporates are worth holding when interest rates rise. will the loss of the NAV outweigh the increase in interest rate of holdings. Also any suggestions of other bond moves that could be of help to me as i plan to use dividends and capital gains to supplement a pension and in time social security. Your thoughts. al

Adam

May 22. 2014

Great move, Ninja.

I didn’t see mentioned above, (maybe I missed it) the biggest benefit to switching from ETFs to dividend stocks… the management fees.

We praise ETFs for having low-cost fees, which is great… but they’re not free. When starting out, the fees are so small we don’t worry about them.

But as you approach financial independence, even a management fee of 0.2% is costing $1,000 for a $500k portfolio… each and every year going foward… vs. buying dividend stocks (many of which will be major holdings in those ETFs), have no fees once you pay for the broker fees. Building your own fund of 20-30 dividend companies will cost you much less.

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